Forecasters predict recession if Congress defaults on debt

If Congress fails to raise the federal debt ceiling and defaults on the nation's debt, the U.S. economy would be at risk of recession and the stock market would be at risk of a severe downturn, according to most of the economic forecasters surveyed by BizTimes today.

BizTimes asked the forecasters to provide answers to three questions.

If Congress does not raise the federal debt ceiling and defaults on the nation's debt, what will happen to the U.S. economy?

"A U.S. debt default, even technical default, has the potential to recreate the money market/liquidity debacle of 2008, but worse. This time around the government backstop of money market funds would be ineffective since the government itself would be the source of the crisis," said Jack Ablin, chief investment officer for BMO Private Bank.

"There also will be an immediate impact on the financial market: Interest rates and inflation will increase while the value of dollar will fall. We also will see a sell-out of Treasury Bonds. In addition, short-term yields could rise," said Abdur Chowdhury, Ph.D. and professor in the Department of Economics at Marquette University.

"Most likely, the government would prioritize its payments, and some creditors (defense contractors, road builders, etc.) would find that the government hasn't paid them on time. Many state and local governments are notoriously slow in paying. This reduces income and slows the economy," said Richard Marcus, Ph.D. and associate professor and chair of the Executive Committee, Finance, at the University of Wisconsin-Milwaukee.

"The moment we cross that threshold, I don't think you would see this immediate reaction from the economy. You obviously would have this psychological impact…but I think that's been going on for some time. There's already this sense that Washington, D.C., isn't working and so you're already starting to have that psychological impact," said William Delwiche, investment strategist at Milwaukee-based Robert W. Baird & Co. Inc.

“It's hard to know for certain, but an important stock market correction is likely. Consumer and business confidence would suffer. Direct Federal spending would remain limited. It's entirely possible that the economy could be thrown back into recession if the impasse lasts deep into the fourth quarter,” said Carl Tannenbaum, chief economist at Chicago-based Northern Trust Bank.

If Congress does not raise the federal debt ceiling and defaults on the nation's debt, what will happen to the U.S. stock market?

"The stock market would likely crash in response to a government default. While the market crashed in 2008-2009, it was the Federal Reserve's quantitative easing program that turned momentum around. The Fed would still be able to buy Treasury securities, but a debt limit would mean the government would soon be insolvent, since it currently spends about $500 billion more than it takes in on an annual basis," Ablin said.

"There also will be an immediate impact on the financial market: Interest rates and inflation will increase while the value of dollar will fall. We also will see a sell-out of Treasury Bonds. In addition, short-term yields could rise," Chowdhury said.

"A default that both raises interest rates and slows the economy will lower stock prices. The amount is a function of how prolonged the disturbance is," Marcus said.

"There I think you get a more immediate reaction. (Policy makers are) going to react to what they see in the market — they can't react to the economic effects because those are so hard to see," Delwiche said.

“See above. So far, the stock market has been taking things in reasonable stride, under the assumption that the situation would be resolved before room underneath the debt ceiling is exhausted. A 10- to 15-percent correction is certainly possible,” Tannenbaum said.

If Congress does not raise the federal debt ceiling and defaults on the nation's debt, will the U.S. economy fall into another recession?

"The dramatic reduction in government operations and the unintended impacts would undoubtedly plunge the U.S. economy into recession. Without government borrowing, it would be a recession from which emerging would be extremely difficult," Ablin said.

"Should a default on debt occur, the results could be severe enough to push the U.S. economy into a recession," Chowdhury said.

"Most likely yes…With an already slow economy, my expectation is that not extending the debt ceiling produces a mild recession. The issue will be if this is a prolonged disturbance or temporary," Marcus said.

"No. I don't think that the risk of recession's real high right now. The truth of the matter is that government spending is relatively low in terms of the overall size of the economy. There's still activity that's happening and will continue to happen," Delwiche said.

“The good news is that economic momentum, both in the U.S. and overseas, has been gathering. Our forecast calls for growth of around 2.5 percent this quarter, assuming that we get a better case outcome from Washington. The bad news is that the economy is still fragile, weaker than it was when the government was shut down for an extended period in 1995. If we go ahead and default, I would put the odds of recession at 20 percent or so,” Tannenbaum said.

Editor's note: BizTimes sent this survey out to additional economic forecasters, and this story will be updated with additional reaction as it becomes available throughout the day.